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What is the likelihood of severe property price correction?

Hong Kong residential property market entered into a correction phase since September last year. Based on the Centa-City Leading Index (CCL), the residential property prices declined around 13% between September 2015 and mid-April 2016. If it is measured by the residential price index from the Rating and Valuation Department (RVD), the residential property prices declined around 12% from September 2015 to March 2016. Even though prices have declined faster than expectation, the Hong Kong residential property market is not likely to have a deep correction ahead if the existing government and HKMA’s measures remain unchanged and there is no significant crisis-type event to occur.

There were only two occasions of deep correction since 1980

According to the RVD statistics, there were only two occasions when Hong Kong residential property prices had declined by more than 30% since 1980. The first time happened between Q3 1981 and Q3 1984 when the residential property prices declined by around one-third. At that time, both the economy and property market performed badly amid concerns over the change of sovereignty in 1997. The second time happened between Q4 1997 and Q3 2003 when the property prices declined by two-thirds, as Hong Kong suffered from severe recession and deflation after the Asian Financial Crisis, tech stock bubble and SARS etc. The Hong Kong property market then declined for six years. However, the market revived since 2H 2003 and the up-cycle lasted for 12 years. Even though there were still ups and downs in the latest property up-cycle, like the residential property prices once declined around 17% during the global financial crisis in 2008, no sharp correction was recorded at that time since prices recovered swiftly after the central banks around the world had implemented aggressive monetary easing. Currently, the Hong Kong residential property market has entered into a correction phase again and declined around 13% from its peak. The market raised concerns about sharp correction, particularly amid an elevated global economic uncertainty, huge financial market volatility, US interest rate hike, and increase in land supply.

Four factors have led to the recent property market correction

1.    The residential property market increased sharply during the up-cycle, and the small and medium-sized flats faced an increasing downward pressure. The residential property market has surged since 2003, with the prices of small and medium-sized flats (units with the size of 100 sq m lower) increased much faster than large-sized flats (units with the size of 100 sq m or above). From the trough in 2003 to the peak in 2015, the prices of small and medium-sized flats increased 4.3 folds, while the large-sized flats only increased 3.2 folds. Comparing with the peak in 1997, the prices of small and medium-sized flats increased 78%, higher than the 53% increase of large-sized flats. Given the property market in 1997 was in a highly unsustainable condition, the roughly same pace of nominal GDP growth and property prices between 1997 and 2015 also likely reflects the unsustainable condition, and does not see much meaningful improvement. However, the current mortgage rate is just around 2%, much lower than the 10% or above in 1997, leading to a relatively less frothy condition than 1997.

In addition, it is not a normal phenomenon that the prices of small and medium-sized flats increased much faster than large-sized flats, given the housing stock of the small and medium-sized flats accounted for over 92% of total in Hong Kong, while the large-sized flats only accounted for less than 8% of total. The prices of small and medium-sized flats rising faster than large-sized flats are mainly because of the increasingly stringent government’s demand management measures and Hong Kong Monetary Authority’s (HKMA) prudential measures for property mortgage loans. These measures increase the costs of property upgrading, investments by overseas individuals as well as local and overseas companies, leading to the more biased demand towards small and medium-sized flats. Indeed, if the peak in Q3 2015 is taken as an example, the affordability ratio for a median income household to purchase a class A residential flat (with a size below 40 sq m) was around 71% (assuming 2% mortgage interest rate and repayment over 20 years), while the affordability for the top 5% income household to purchase a class D residential flat (with a size between 100 and 159.9 sq m) was 54%. Even though both the affordability ratios were below 95% and 90% at their peak in 1997 respectively, it showed that the share of mortgage payment to household income was quite high for the small and medium-sized flats. With the sharp increase in property prices over the past 12 years, and particularly for the small and medium-sized flats, the property market has entered into a correction phase since September last year.

2.    Global economic slowdown and severe global financial market volatilities kicked in. Between 2H 2015 and February 2016, the downward pressure of the global economy intensified, together with the US interest rate hike, relatively strong US dollar exchange rate, sharp decline of commodity prices, currencies depreciation and capital outflows from the emerging economies etc. The global financial markets staged a series of extreme volatilities. As a small and open economy, Hong Kong was also affected inevitably. Hong Kong dollar exchange rate had once depreciated towards the weak-side convertibility undertaking in January 2016, leading to a convergence of US dollar and Hong Kong dollar interest rates. Meanwhile, Hong Kong external performance was affected by the sluggish global economic recovery, and the tourism and retail sectors were also under correction. The concerns over weaker economic and employment outlook ahead has no doubt affected the residential property market performance.

3.    The US Federal Reserve raised rates in December last year. In December 2015, the US Federal Reserve formally put an end to its zero interest rate policy and raised rates by 0.25 percentage point. At that time, the Federal Open Market Committee (FOMC) participants’ assessment of appropriate monetary policy showed that the median participant expected the Federal Reserve will raise rates by 1, 1, and 0.875 percentage point in 2016, 2017 and 2018 respectively. Given Hong Kong has a linked exchange rate system with the US, the Hong Kong dollar interest rate has to follow that of the US. As such, the US interest rate hike in December last year has rekindled concerns over a new interest rate cycle and increasing burden of the mortgage payments in Hong Kong. This further enhanced the expectation of a property market correction, with more landlords willing to cut price to sell their properties, further affecting the residential property market in Hong Kong.

4.    Increasing in land supply and the government’s housing supply target is within reach. Without doubt, the current government strives to increase short, medium and long term land and housing supply, and is expected to continue this strategy even though the economy is facing an increasing downward pressure. According to the RVD statistics, the number of private housing completion will reach 18,200 and 17,930 for 2016 and 2017 respectively, both are the highest level since 2004 and within close reach of the government’s 18,000-19,000 private housing supply target. Moreover, the statistics from the Transport and Housing Bureau (THB) showed that there will be 92,000 potential new private housing supply in the coming three to four years, the highest level since its record began in 2004. The concerns over the increase in housing supply in the near future is another negative factor for the residential property market in Hong Kong.

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Content provided by Bank of China (Hong Kong)
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